Bye-bye, Bon-Ton: Liquidation is coming

Last week, bankrupt department store operator Bon-Ton Stores(NASDAQ: BONT) made one last desperate bid to survive. A group led by mall owners Namdar Realty Group and Washington Prime Group(NYSE: WPG) signed a letter of intent to buy the company out of bankruptcy and continue operating at least some of its stores.

Not surprisingly, this bid fell through within a few days. The only bidders that showed up to the bankruptcy auction held earlier this week were liquidators. Thus, on Tuesday evening, Bon-Ton's management confirmed the inevitable: The chain will be liquidated over the next few months. This is bad news for many of its landlords.

The end of the road

The liquidation of Bon-Ton has been a long time in the making. The company, which operates department stores under seven different localized nameplates, has been unprofitable since 2011.

Bon-Ton has kept itself alive until now by cutting spending and investment to the bone. However, that only further undermined its long-term competitiveness. As a result, Bon-Ton suffered mightily in last year's difficult retail climate. Through the first three quarters of fiscal 2017, revenue fell 7.5% and the company's net loss widened by more than $25 million.

A brief sales rebound in November quickly petered out, forcing Bon-Ton to file for bankruptcy in early February. Given the company's persistent unprofitability and its lack of scale compared to its top rivals, management's attempts to keep the company intact through the bankruptcy process were a long shot from the start.

Bon-Ton will close all of its stores and liquidate in the next few months. Image source: Bon-Ton Stores.

The going-concern bid spearheaded by Namdar and Washington Prime made sense only because both companies had a vested interest in keeping Bon-Ton in business to support the value of their properties. However, they appear to have shelved their plans after a bankruptcy court judge blocked Bon-Ton from paying $500,000 to cover their due diligence costs. In any case, these would-be buyers weren't willing to pay full market value for the company's assets. That left liquidation as the only option.

Another body blow for mid-tier mall owners

Bon-Ton's disappearance is likely to cause even more distress for Washington Prime and CBL & Associates Properties(NYSE: CBL). Both mid-tier mall operators have been suffering from department-store chains closing anchor locations at their properties.

Washington Prime and CBL view anchor-store closures as opportunities to redevelop those spaces for higher-paying tenants. However, anchors are closing faster than they can be replaced. Moreover, the smaller tenants that typically generate most of a mall's rental income often have "co-tenancy clauses" that grant them reduced rent -- or the right to terminate their leases entirely -- when an anchor leaves. This can quickly decimate a mall's income and cash flow.

Unfortunately, Washington Prime and CBL both have exposure to Bon-Ton in about a quarter of their malls. It will be extremely difficult to find new tenants for all of this space within the next year. Furthermore, if other tenants invoke co-tenancy clauses due to the Bon-Ton liquidation, the resulting reduction in cash flow could make it hard to finance renovations.

To make matters worse, Washington Prime and CBL each have a massive number of Sears Holdings stores in their portfolios. Considering Sears' recent plunge toward insolvency, these mall owners are likely to have plenty of additional anchor space becoming vacant in the next year or two.

Will any department stores fill the vacuum?

The easiest way to repurpose Bon-Ton's space would be to lease it to other department stores. None of the major U.S. department-store chains are looking to grow right now, though. They will instead try to capture as much of Bon-Ton's business as possible in their existing stores and online.

In a best-case scenario, Washington Prime and CBL may be able to shore up some of their mid-tier properties by convincing department stores to relocate stores from nearby malls that are in even worse shape. (Of course, they could also be victims of this strategy, if any of their healthier anchor tenants are offered incentives to relocate to nearby malls.)

However, in most cases, it will be necessary to completely redevelop these large department store spaces for smaller tenants. That's a capital-intensive process. CBL already had to cut its dividend in 2017 to help preserve capital for potential redevelopment projects, and Washington Prime could face a similar dilemma soon. The Bon-Ton liquidation is just one more reason to avoid these struggling mid-tier mall operators.

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